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Selling your home can be a major life event. It's important to understand the federal tax implications before you put your house on the market. One of the biggest concerns for homeowners is how to minimize their federal tax liability when they sell their house.

The Internal Revenue Service (IRS) plays an important role in the sale of your home. When you sell your home, you may be required to pay taxes on the capital gain. This is the difference between the sale price and your adjusted basis. (the purchase price plus any improvements you've made to the home, minus depreciation)

Minimizing your tax liability when selling your house takes careful planning and understanding of the applicable tax regulations.

Here are some key strategies to consider:

  1. Qualify for the home sale exclusion. This exclusion allows you to exclude up to $250,000 ($500,000 for married couples filing jointly) of capital gains from the sale of your primary house from your taxable income. To qualify, most have owned and used the home as your primary home for at least two of the five years leading up to the sale.
  2. Maximize deductions. Take advantage of allowable deductions to reduce your taxable income. These deductions may include expenses related to home improvements, selling costs, and depreciation. Keep meticulous records of all expenses to support your deductions.
  3. Time the sale strategically. If you have other income deductions, such as charitable contributions or medical expenses, consider selling your home in a year when you can claim these deductions to further reduce your overall tax liability.
  4. Seek professional guidance. Consult a tax professional to ensure you are maximizing tax benefits and complying with all applicable regulations. They can help you understand the nuances of the home sale exclusion, identify eligible deductions, and develop a comprehensive tax-minimization strategy.
  5. Understand the implications of selling to family or friends. Selling your home to a family member or friend may disqualify you from certain tax benefits, such as the home sale exclusion. Carefully evaluate the tax consequences before proceeding with such a transaction.
  6. Be mindful of selling at a loss. If you sell your home for less than you paid for it, you may not be able to deduct the loss from your taxable income. Consult a tax advisor to understand the specific rules governing loss deductions.
  7. Consider deferred capital gains. If you defer capital gains from the sale of your home, you may eventually have to pay taxes on those gains. Evaluate the long-term tax implications of deferring gains.

By implementing these strategies and seeking professional guidance when needed, you can effectively minimize your tax liability when selling your house and maximize your financial gains.

Other Possible Deductions

In addition to the home sale exclusion, there are a number of other deductions that you may be able to claim when you sell your home. These deductions may include expenses related to selling your home, such as real estate commissions and closing costs. You may also be able to deduct certain home improvements that you made in the years leading up to the sale.

Source: Internal Revenue Services

Here are some additional tips that may be helpful:

If you are selling your home, it is important to report the sale on your tax return. You will need to report the sale price of your home, your adjusted basis, and any capital gains or losses that you realized from the sale. You may also need to report any deductions that you are claiming related to the sale of your home. Selling your home can be a complex process, but it doesn't have to be overwhelming. By following these tips, you can ensure that you are reporting the sale of your home to the IRS correctly and minimizing your tax liability.

Blue Heron CPAs often performs business consulting for those thinking about forming an S Corporation. There are many questions we ask that go far beyond the tax liability, like reasonable compensation. To ensure that an S Corporation is the right entity structure for our clients as it relates to taxes. Much of those questions relate to managing basis, paying yourself in an S Corporation, and the expected normal operations of the company. Understanding the consequences of making an S election is important.

This article identifies potential red flags that we commonly see in S Corporations. This article does not identify all errors or all issues we commonly see. This resource intends to help individuals educate themselves through proper communication with their tax preparers. Your tax preparer should be capable of having a conversation towards any of the below topics. This will help further qualify whether that preparer is the correct person for the service you are being provided.

S Corporations

Many small business owners form S Corporations to take advantage of significant tax benefits, especially those related to self-employment taxes. However, navigating the complexities of S Corporation operations can be challenging. Prior to electing an S Corporation, you should evaluate the complexities for whether you intend to comply with the law. In this blog article, we'll explore three common issue areas we see in S Corporations: reasonable compensation, managing your basis, and mileage for personal cars. Many tax preparers put the responsibility of compliance for these requirements on the taxpayer. Taxpayers are responsible for accurately and properly filing their tax returns and following the rules and regulations for their respective entities.

Reasonable Compensation: Paying Yourself In An S Corporation

One of the most critical issues for S Corporation owners is paying yourself in an S Corporation, also known as "reasonable compensation." The IRS closely scrutinizes the salary that owners pay themselves. This prevents individuals from reducing their tax liability by paying too little in wages and taking the rest as distributions. Here are some key points to consider when paying yourself in an S Corporation:

What is Reasonable Compensation?

Reasonable compensation is the salary an S Corporation owner or shareholder should pay themselves for their work within the business. There is no direct guidance on how to calculate reasonable compensation but the IRS guidance below discusses a potential calculation.

Documentation Matters

Proper documentation on how you came to your salary number is crucial. Maintain records of salary surveys, job descriptions, and any other information that supports the chosen salary level. This documentation is invaluable in case of an IRS audit.

Tax Implications

Reasonable compensation is subject to payroll taxes (Social Security and Medicare), while distributions are not. Paying too little in salary can lead to IRS penalties and additional tax liabilities including their ability to classify past distributions as wages.

Social Security in Retirement

There are consequences to underpaying self-employment tax. When calculating a Social Security benefit during retirement, reduced wages can heavily reduce the future benefit you receive.

IRS Guidance on S Corp Reasonable Compensation

How To Ask The Question To The Preparer:

“I was reading into S Corporation requirements, and it mentions reasonable compensation as a requirement to operate as an S Corporation. Should I be on the company’s payroll and am I taking the proper amount of salary?”

To ensure compliance, it's advisable to consult with a tax professional. A professional can help determine a reasonable compensation level that aligns with IRS guidelines and industry standards.

Managing Your Basis: The Foundation of Tax Planning

Basis in an S Corporation is the investment that the shareholders have in the company. Like understanding the cost of what you put into a house when you sell it or stocks as you sell them, you have a basis in your company. The IRS requires taxpayers to track their basis, a crucial calculation for tax purposes. Basis may not affect your income and the taxes you owe every year which is why it is a hidden dagger that has severe tax consequences in future years.

Increased Basis

Basis can increase through various means. I usually think of this as putting additional investment into the business.

Decreased Basis

Managing Your Basis

Your company’s basis is recognized through Schedule M-2 which is located on Page 5 of the 1120-S. It is required for every S Corporation to track and report basis properly. On your individual return, a Form 7203 is likely filed to report the individuals basis within the S Corp.

Identifying Basis Mismanagement

Signs of basis mismanagement include the following common red flags. If you see any of the following, it is worth asking your accountant if your basis is accurately tracked and why it is reported this way. The below does not identify that a mistake has been made. It identifies that there is a high likelihood that you should talk to your accountant.

  1. Negative Basis reported on M-2 line 8, Balance at the end of the year.
  2. If you have withdrawn money outside of salary, Line 7 on the M-2 should have a value within it.
  3. No basis reported on Line 1 of the Schedule M-2
  4. Large numbers reported on Line 3 or Line 5 of the Schedule M-2 unless significant investment has been made by the shareholders.
  5. If you have not taken out a loan, Line 8 of Schedule M-2 may be similar to the current value of cash, inventory, and equipment you have in the company. If there is a dramatic difference, it is worth asking your accountant why.
  6. If Line 7 has a number of the Schedule M-2 but no Form 7203 exists on your individual tax return.

IRS Guidance on S Corp Basis Consideration

How To Ask The Question To The Preparer:

“I was reading into S Corporation requirements to manage your basis. I was hoping you might be able to explain the Schedule M-2 to me along with my Form 7203.”

To properly manage your basis, work closely with a tax professional who specializes in S Corporations. They can help you establish a basis tracking system, maintain accurate records, and ensure that you're compliant with IRS regulations.

Vehicle Expenses for S Corporation Owners

Have you ever been advised by TikTok or a friend to title a new vehicle under the business because it becomes a tax deduction? Your friend might be right, but they are likely not explaining the entire story for how you must treat that vehicle for the future. S Corporation owners often use personal vehicles for business purposes. S Corporation owners also may use business vehicles for personal use. Keep in mind that shareholders who are actively working within the S Corporation are considered employees of the S Corporation. Properly handling vehicle expenses is essential for tax efficiency but also a requirement to the IRS which reduces tax liabilities. Here are some key considerations:

Personally Owned Vehicle

  1. Business Mileage Deductions: S Corporation owners may reimburse the mileage driven for business purposes as a mileage reimbursement. Keeping detailed records of business-related trips, including dates, destinations, and mileage is required. We recommend using a mileage app that automatically tracks your trips as a resource for creating a mileage log. The IRS provides a standard mileage rate that can be used for reimbursement.
  2. Personal Use vs. Business Use: Clearly distinguish between personal, commute, and business use of your vehicle. Only the mileage driven for legitimate business purposes may be reimbursable.
  3. Expense Reimbursement: If your S Corporation reimburses you for vehicle expenses, ensure that the reimbursement is properly documented and aligned with IRS regulations. Excess reimbursement may have tax consequences.
  4. Accountable Plan: It is recommended for S Corporations to have an Accountable Plan to determine the reimbursements to employees along with other fringe benefits.

Business Owned Vehicle

  1. Leasing the Vehicle: Personal use of a business vehicle is considered a fringe benefit which may be taxed as income to the employee. See Publication 15-B for further guidance.
  2. W-2 Reporting: Your payroll provider should be made aware of the total income to be associated as wages to the employee with the proper codes identified on the W-2.
  3. Mileage Tracking: The IRS still requires that mileage be tracked in the case that a business vehicle is personally utilized by an employee.
  4. Majority Business Use: Deductions may be disallowed, and income may be assigned to the employee in the case that an employee is utilizing a business vehicle for majority personal purposes.

IRS Guidance on S Corp Employee Fringe Benefits:

There is not great guidance specifically towards the topic of vehicles held in S Corporations. There are common mistakes around vehicle deductions through business vehicles titled in the business’ name.

How To Ask The Question To The Preparer:

I have been researching how to get the maximum amount of deduction for my business vehicle and I came across an article describing the mileage reimbursement for personal vehicles. Are we currently performing a reimbursement and are we claiming a deduction?

I hope this article is helpful to those who have trouble approaching tough conversations about accounting and taxes. It is important to remember that the taxpayer, you, is ultimately responsible for your tax return and the numbers included on that return.


S Corporations offer numerous advantages, but they also come with complexities that require careful attention. Understanding reasonable compensation, basis, and mileage reimbursement rules is crucial for maintaining compliance with tax regulations and optimizing your tax strategy. Consulting with tax professionals, keeping accurate records, and managing basis effectively will help you navigate these challenges successfully and maximize the benefits of your S Corporation structure.

If you consistently owe taxes at the end of the year when filing your Form 1040 (U.S. Individual Income Tax Return), there are several common reasons why this might be happening. Understanding these reasons can help you take steps to better manage your tax liability. Here are some potential explanations for consistently owing taxes:

Insufficient Withholding:

One of the most common reasons for owing taxes at the end of the year is that your income sources did not withhold enough federal tax. This can happen for many reasons:
1. Improperly Filled Out W-4: Though it appears to be easy, Form W-4 (Employee's Withholding Certificate) can be complicated based on your position and potential life changes.
2. Multiple sources of income: Form W-4 allows you to identify multiple sources of income and withhold.
3. Updating Form W-4: Submitting a new Form W-4 to the source of income will update your circumstances to the payroll processor or custodian. This will update the amount withheld for each source of income.

Underestimated Estimated Tax Payments:

If you are self-employed or have income that is not subject to withholding, you may be required to make estimated tax payments throughout the year. Owing at the end of the year can occur if you underestimate your tax liability when making these payments. To avoid this, it's important to accurately estimate your tax liability and make timely estimated payments.

Changes in Income or Deductions:

Major life changes such as a change in income, marital status, or the birth of a child can impact
your tax liability. If you don't adjust your withholding or estimated payments to account for these changes, you may end up owing more when you file your return.

Tax Credits and Deductions:

Owing taxes at the end of the year can also result from not taking full advantage of available tax credits and deductions. Some taxpayers may not be aware of all the credits and deductions they are eligible for, or they may not have kept adequate records of their expenses.

Capital Gains or Investment Income:

If you have capital gains from investments or other sources of taxable income beyond your regular
salary, you may owe additional taxes. These types of income are often subject to different tax rates and may not have sufficient withholding. Since investment income may vary greatly by year, consulting with
your financial advisor or custodian is important. Ask about large transactions or large gains/losses being recognized. State and Local Taxes:

State and Local Taxes:

Remember that your federal income tax return is only part of your overall tax picture. If you live in a state or locality with income taxes, your overall tax liability may be higher, and you could owe state and local taxes in addition to federal taxes.

To avoid consistently owing taxes at the end of the year, consider the
following steps:

Taxes will be a consistent burden for the rest of your life but should not be similar to gambling. By taking a proactive approach to managing your tax liability throughout the year, you can help prevent the unpleasant surprise of owing taxes when you file your Form 1040. If you would like to schedule a consultation to better understand why you owe at the end of each year, please click the button below. We are happy to help you understand the source of your tax liabilities.

Tax season can be a daunting time for many individuals and businesses alike. Consequently, understanding the intricate details of the U.S. federal tax system is no small feat, and one aspect that often confuses taxpayers is estimated payments. In this article, we will explore the concept of estimated payments for federal tax purposes, demystify the process, and offer guidance on how to manage your tax obligations more effectively.

What Are Quarterly Payments or Estimated Payments?

Estimated payments, also known as estimated taxes, are a method used by individuals and businesses to pay their federal income tax liabilities throughout the year. The U.S. tax system operates on a "pay-as-you-go" basis, meaning taxpayers are required to make payments throughout the year rather than waiting until the end of the tax year to settle their tax bill. As a result, this approach helps the government collect revenue regularly and prevents taxpayers from facing large, unexpected tax bills.

Do I need to file estimated payments?

Estimated payments are typically required for the following groups:
1. W2 Employees: If you are an employee who typically owes at the end of the year or you have requested decreased withholding on your W4, you may be required to make payments to avoid penalty and interest.
2. Self-Employed Individuals: If you are self-employed, a freelancer, or a gig worker, you likely don't have taxes withheld from your income. In this case, you are responsible for making estimated tax payments.
3. Business Owners: Owners of certain types of businesses, such as sole proprietorships, partnerships, S corporations, and some LLCs, are generally required to make estimated tax payments.
4. Investors and Rental Property Owners: If you receive income from investments or rental properties and do not have sufficient taxes withheld, you may need to make payments.
5. High Earners: High-income individuals who receive a substantial amount of income not subject to withholding, such as capital gains or dividends, may also need to make payments.

What Happens if I Don’t Make Estimated Payments?

Failing to make estimated tax payments when required by the IRS can result in severe penalties and interest charges. Consequently, these penalties are designed to encourage taxpayers to meet their tax obligations throughout the year rather than waiting until the end of the tax year. Here are the key penalties you may face for not making estimated payments:

Underpayment Penalty (Form 2210): This penalty is assessed when you haven't paid enough in estimated taxes by the due dates. The penalty is typically calculated on a quarterly basis. Therefore, to avoid this penalty, you must meet one of the following: a safe harbor requiring you to pay either 90% of your current year's tax liability or 100% of the previous year's tax liability (110% if your adjusted gross income exceeds $150,000 for individuals or $75,000 for married couples filing separately). Keep in mind that different rules may apply to high-income individuals along with other specialized industries.

Late Payment Penalty: If you don't make your estimated tax payments by their due dates, you may be subject to a late payment penalty. This penalty is calculated based on the amount of taxes owed and the number of days the payment is late. The IRS sets the interest rates for late payments, which can
change periodically.

Interest Charges: In addition to penalties, you may also be required to pay interest on the amount of underpaid taxes. Furthermore, the interest rate is determined by the IRS and is generally based on the federal short-term rate plus 3%. The interest rate today is significantly higher than the rates for the past decade.
Topic No. 653

Failure to File: A penalty often assessed at the same time as underpayment penalties is the Failure to File penalty. Interest is also assessed on penalties as those penalties are assessed.

Important to Note:

While the penalty for underpayment of estimated taxes is not a fixed percentage of the underpaid amount, it is still important to be aware of the factors that can affect the penalty amount, such as the amount of underpayment, the timing of the underpayments, and the applicable interest rates.

How Are Estimated Payments Calculated?

Calculating your estimated tax payments is complex, as it depends on your income, deductions, credits, and other factors. Therefore, the simplest calculation involves estimating your total tax owed for the year and then dividing it into four equal quarterly payments.

Here's a simplified formula to help you get started:

1. Estimate your adjusted gross income.
2. Calculate your anticipated deductions and credits.
3. Determine your taxable income.
4. Apply the appropriate tax rate to your taxable income.
5. Divide your estimated annual tax liability by four to get your quarterly
payment amount.

Even though your income fluctuates throughout the year, or on a year-by-year basis, you may need to adjust your estimated taxes accordingly each year. This situation is most common for businesses trying to calculate their estimated business tax payments. In this case, having consistent bookkeeping up-to-date along with a forecast is the best way to accurately calculate your tax liability at the end of the year.

When Are Estimated Payments Due?

The IRS has set specific due dates for tax payments:

1. First Quarter: April 15
2. Second Quarter: June 15
3. Third Quarter: September 15
4. Fourth Quarter: January 15 of the following year (for the previous tax

It's crucial to mark these dates on your calendar and ensure you make your payments on time. Consequently, failure to do so can result in penalties and interest.

How do I pay my estimated tax payments?

Making tax payments is relatively straightforward:

1. Pay Online: The IRS offers an online payment system that allows you
to make payments electronically. You can use the Electronic Federal
Tax Payment System (EFTPS) or pay directly on the IRS website.
2. Mail a Check: If you prefer to pay by check, you can download Form
1040-ES from the IRS website and follow the instructions to mail your
3. Use a Tax Professional: Many tax professionals and accountants can
help you calculate your estimated payments and ensure they are
submitted on time.

Therefore estimated payments for federal tax purposes are an essential aspect of the U.S. tax system. By understanding who needs to make these payments, how they are calculated, and when they are due, you can stay on top of your tax obligations and avoid potential penalties and interest charges.
Despite the challenges of estimated tax payments, they are a proactive way to manage your tax liability and ensure you meet your obligations to the IRS. Additionally, consider working with a tax professional or using tax preparation software to streamline the process and help you accurately estimate and pay your taxes throughout the year. This proactive approach can lead to smoother tax seasons and better financial planning for the future.

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